T he lat t er t ype of debt ext inguishment is somet

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Unformatted text preview: urit y or prior t o mat urit y. T he lat t er t ype of debt ext inguishment is somet imes c alled reac quisit ion of debt . Simply put , reac quisit ion involves buying bac k t he debt , eit her by exerc ising a c all f eat ure or t hrough an open- market purc hase. T he f ollowing example illust rat es ret irement of bonds prior t o mat urit y. Sc enario $100,000, 10% (c oupon rat e), 5- year bonds were issued on January 1, 2008 when t he market rat e was 12%. T he bonds pay int erest semi- annually on June 30 and Dec ember 31. T he bonds are c allable at 102. T he c ompany c irc umst anc es c hange, and t hey c all t he bonds on Marc h 31, 2008. Complet e t he journal ent ries t o rec ord t he redempt ion of t he bonds. Assume t hat t he c ompany amort izes all premiums or disc ount s on an ef f ec t ive rat e basis. St eps t o Rec ord t he Issuanc e of t he Bond 1. Calc ulat e t he issue pric e of t he bonds. Using a f inanc ial c alc ulat or: F V = 100,000, n = 10 (5 years x 2 int erest payment s per year), i = 6% (int erest is half of t he annual 12% market rat e bec ause t he int erest is paid semi- annually), and PMT = 100,000 x 10%/2 = 5,000 (int erest is paid at half t he c oupon rat e t wic e a year). https://blackboar d.tr u.ca/webct/ur w/lc5122001.tp0/cobaltM ainFr ame.dowebct 5/9 9/10/13 Blackboar d Lear ning System 2. T he bonds would have been issued f or $92,640. T his is t he present value of t he t wo st reams of c ash f lows. 3. Calc ulat e t he premium or disc ount . Sinc e t he bonds were issued f or less t han t he f ac e value, t hey were issued at a disc ount . T he amount of t he disc ount is $7,360 ($100,000 f ac e value – $92,640 issue pric e). 4. Prepare t he journal ent ry t o rec ord t he issuanc e of t he bond. T he journal ent ry would be: St eps t o Rec ord t he Redempt ion 1. Det ermine t he int erest expense up t o t he redempt ion dat e: (92,640 x 12% x 3/12 = $2,779). 2. Det ermine t he int erest t hat is payable at redempt ion: ($100,000 x 10% x 3/12 = $2,500). 3. Prepare a journal ent ry t o rec ord t he int erest owing and amort ize t he disc ount . T he journal ent ry would be: 4. Calc ulat e t he c all premium: $100,000 x (1.02 c all pric e – 1.00 f ac e value) = $2,000 5. Calc ulat e t he c ash t o be paid out : ($100,000 f ac e value + $2,500 ac c rued int erest + $2,000 c all premium) = $104,500 6. 6. Rec ord t he journal ent ry as f ollows: * T he gain or loss on ret irement is t he amount nec essary t o make t he journal ent ry balanc e ($104,500 + $7,081 – $100,000 – $2,500 = $9,081). When we remove an it em https://blackboar d.tr u.ca/webct/ur w/lc5122001.tp0/cobaltM ainFr ame.dowebct 6/9 9/10/13 Blackboar d Lear ning System f rom our balanc e sheet , we must also remove all relat ed ac c ount s wit h t he net dif f erenc e bet ween t hese amount s and t he c ash given up or rec eived represent ing a gain or a loss. Ac t ivit y 2- 2: Bond Valuat ion Introduction T his ac t ivit y will reinf orc e you...
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